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Contact Officer and Copyright Details
The purpose of the Taxation Laws Amendment (Software
Depreciation) Bill 1999 (the Bill), is to:
- Modify depreciation provisions to allow a deduction over 2.5
years at 40 per cent, for expenditure incurred in acquiring,
developing or commissioning software
- Provide an option to create a pool for expenditure on the
development or commissioning of software
- Allow an immediate deduction for expenditure incurred, before 1
January 2000, on ensuring that an existing computer system attains
Y2K compliance (including acquiring new software or substantially
rebuilding current software) where the principal purpose is
ensuring Y2K compliance, and
- Provide transitional provisions to allow an immediate deduction
for expenditure incurred until 30 June 1999 on software projects,
which commenced before 10.00 am AEST on 11 May 1998.
1. Deductions and depreciation
The tax base upon which tax is imposed is
'taxable income'. 'Taxable income' equals assessable income minus
Two types of deductions are allowed. First, a
general deduction - which is any loss or outgoing to the extent
that it is incurred in gaining or producing assessable income or is
necessarily incurred in carrying on a business for the purpose of
gaining or producing assessable income. Second, a specific
deduction - which is an amount deductible under specific
In general, personal expenses and capital
expenditure are not deductible. However, there are important
exceptions including deductions for the depreciation of plant.
A deduction for depreciation is allowable on
property which qualifies as plant used during the income year for
the purpose of producing assessable income or which is installed
ready for use for that purpose and held in reserve.
The primary factor in determining whether an
item of property qualifies as plant is its function. If the
function is to provide the setting or environment within which
income producing activities are conducted (eg an office building),
an item will not qualify as plant. Conversely if the function is
essentially the permanent means or apparatus used to produce the
income (eg machines) the item qualifies as plant, whether it is
fixed or movable.
2. Position for deductibility of
software prior to 11 May 1998, including the withdrawal of Taxation
Ruling IT 26
Prior to 11 May 1998, software costs were
generally deductible in the year incurred in accordance with former
Taxation Ruling IT 26.
The costs of 'software' or 'programs' were
accepted as revenue expenses deductible under section 51(1) of the
Income Tax Assessment Act 1936. Where, however, the
software was sold as an integral part of the computer system
itself, for example, because of the technical nature of the
computer system, the total computer system would be subject to
depreciation and the investment allowance.
Taxation Ruling IT 26 was withdrawn at 10.00 am
AEST on 11 May 1998 because the Commissioner of Taxation concluded
that it no longer reflected the correct application of existing law
in relation to software. The proposed amendments will apply to
software expenditure incurred after that time.
The Bill is based on the assumption that the
cost of software is not allowable as an outright deduction under
the general deduction provisions because the expenditure is of a
3. Year 2000 problem
The Year 2000 (or Y2K) problem, also known as
the 'Millennium Bug', is found in computers that use the older
two-digit date code format.
In the early days of computing, a programming
convention developed whereby the date function used a 2-digit-year
(YY) format instead of a 4-digit-year (YYYY) format, (for example
'99' for '1999'). The two-digit date code format assumes that the
century is '19' and as a consequence from midnight in the year
2000, the '00' will be interpreted as 1900 rather than 2000.
It is possible that computing systems may
malfunction or completely fail from midnight in the year 2000
because the Y2K problem restricts their ability to accurately
process date-related information for the year 2000 and beyond.
1. Software Depreciation
Schedule 1 amends the
Income Tax Assessment Act 1997 to include new
Division 46 - Software, which has four new Subdivisions
being, new Subdivision 46-A Definitions and scope
of Division, new Subdivision 46-B Depreciation of
software, new Subdivision
46-C Deductions for certain expenditure on software and
new Subdivision 46-D Software pools.
From 11 May 1998 software costs are to be
subject to the depreciation provisions.
- Expenditure incurred in acquiring, developing or commissioning
software will be amortised(1) at 40 per cent per year on a prime
cost basis(2), ie over 2.5 years.
- Software purchases of $300 or less will continue to be eligible
for an immediate deduction provided that the total cost of all
purchases of identical software does not exceed $300 in any income
- Expenditure on software which has not been used or installed
ready for use and which will never be used will be eligible to be
- A once only election may be made to pool expenditure on
developing and commissioning software provided that the expenditure
is not otherwise deductible under provisions relating to minor
amounts or Year 2000 compliance. Deductions for expenditure in Year
1 are written off at 40 per cent in the following two years and 20
per cent in the fourth year.
1.2 Meaning of software
New section 46-5 defines
software to include 'a right to use software'. Rights to use
software may arise as a result of simple licence agreements or more
complex sub-licence arrangements, which may be in place as a result
of the outsourcing of an information technology function.
1.3 Depreciation of software
New Subdivision 46-B provides
for the depreciation of software.
Depreciation will apply to units of software on
which expenditure is incurred as if they were units of plant owned
by the taxpayer.
Therefore, a licence to use software will be
treated as a unit of plant for the purposes of the depreciation
Pursuant to new sections 46-30,
46-35, 46-40 and
46-45 'expenditure on software' will be amortised
at 40 per cent per year on a prime cost basis, ie over 2.5
'Expenditure on software' is a defined term in
new section 46-10 and includes expenditure in
acquiring, developing or having another person develop software. It
may also include salary or wages paid to a person who is involved
with the development of the software.
Pursuant to new section 46-15
the provisions do not apply to expenditure on software if the
software is trading stock(3) or if a more favourable deduction is
allowable for the expenditure under other provisions of the
1.4 Deductions for software expenditure
New Subdivision 46-C allows
deductions for certain expenditure on software.
Under new section 46-65
expenditure on software purchases of $300 or less will be eligible
for an immediate deduction provided that the total cost of all
purchases of identical, or substantially identical software does
not exceed $300 in any income year.
Under new section 46-70
expenditure on software that has not been used or installed ready
for use and which will never be used will be eligible to be
deducted provided that the expenditure does not form part of a
software pool (see below). The amount of the deduction will be the
total expenditure on the software less any amount of consideration
derived in relation to the software.
1.5 Software pools
Under new Subdivision 46-D a
taxpayer may elect to pool expenditure on developing and
A software pool is created under new
subsection 46-80(1) by recording in writing the first
income year for which expenditure on software is to go into it.
Once made, the choice cannot be revoked, although there is a
limited exception to this for the transitional period. (New
Pursuant to new subparagraph
46-85(d) the expenditure must not otherwise be deductible
under new section 46-65 (relating to amounts under
$300) or new section
46-75 (relating to Year 2000 compliance).
Deductions for expenditure in a particular year
of income (Year 1) are written off at 40 per cent in Years 2 and 3
and 20 per cent in Year 4 in accordance with new section
All expenditure incurred on software development
that commenced in the income year when the choice is made will be
pooled, including expenditure on projects that were completed, and
projects which were abandoned during the income year.
1.6 Transitional rules
1.6.1 Immediate deduction for expenditure incurred before 10am
on 11 May 1998
Transitional provisions in Item
22 allow an immediate deduction for expenditure on
software incurred before 1 July 1999, if at or before 10.00am by
legal time in the Australian Capital Territory on 11 May 1998 (the
- a contract to acquire the software had been entered into,
- development or commissioning of the software had
Thus expenditure can be deducted for the year in
which it is incurred rather than having to write it off gradually
under new Subdivisions 46-B or
1.6.2 Backdating software pool to 11 May 1998
Special transitional arrangements in
Item 23 provide that where a decision is made to
pool expenditure under new section 46-80 for the
first income year beginning after the Relevant Time, a taxpayer may
elect that the choice be treated as applying to expenditure on
software incurred after the Relevant Time but before the
commencement of the first income year.
This effectively brings forward deductions for
that particular expenditure by one year because the deductions for
pooled expenditure on software under new section
46-90 depend on the income year in which expenditure was
incurred and not when the choice to pool expenditure was made.
In addition, further transitional provisions in
Item 24 enable a taxpayer to revoke a previous
choice to create a software pool when lodging a return for the
second income year beginning after 11 May 1998. If a revocation is
made expenditure incurred before the second income year remains in
the software pool.
2. Year 2000 Expenditure
Under new section 46-75
expenditure on software incurred before 1 January 2000 can be
deducted if the principal purpose of the expenditure is to ensure
that an existing computer system attains Year 2000 compliance.
2.2 Deductions for expenditure on new software or
substantially rebuilding current software only available if
expenditure incurred before 1 January 2000
On 5 August 1998 the Commissioner of Taxation
released draft Taxation Ruling
TR 98/D5, which discussed the treatment of expenditure to achieve
Year 2000 compliance.
The ruling stated that expenditure incurred on
acquiring new software or substantially rebuilding current software
would not be immediately deductible being capital in nature.
However, the final ruling TR 98/13 Income
tax: deductibility of Year 2000 (millennium bug) expenses was
expanded to specifically acknowledge the Government's budget
announcement that legislation would be introduced to ensure
deductibility for expenditure on new software (including upgrades)
or on substantially rebuilding current software.(4)
New section 46-75 is the
legislative mechanism to ensure that expenditure on such software
will be immediately deductible provided that it is incurred before
1 January 2000 and the taxpayer intended to use the software or
have it installed ready for use for the purpose of producing
assessable income when the expenditure was incurred. After this
date Taxation Ruling TR 98/13 will reflect the Commissioner's view
on the deductibility or otherwise of such expenditure.
3. Diagram explaining the operation of
new Division 46
The Explanatory Memorandum to the Bill(5)
provides a very useful overview of new Division 46
in diagrammatic form.
1. Certainty regarding Y2K
Without Taxation Ruling IT 26, which was
withdrawn on 11 May 1998, software costs fell into 'a tax black
The Commissioner had advised the Treasurer that
without a legislative response, the withdrawal of IT 26 would mean
that systems and application software would generally not be
subject to amortisation, or, at best, would be amortised over 25
The decision to allow relatively generous(8)
write-offs for expenditure incurred to ensure that an existing
computer system attains Year 2000 compliance should resolve any
uncertainty in relation to the taxation treatment of expenditure
and provide the incentive for business, in particular small
business, to take action on the problem.(9)
2. New software regime is not a
The business community, while welcoming the
taxation measures for expenditure associated with Year 2000
compliance have indicated that the general software amortisation
provisions will have a longer term effect with greater revenue
implications(10) than the immediate deductibility of Y2K
It has also been noted(11) that the new
amortisation system will entail keeping sufficient records to
identify expenditure that is not immediately deductible, and seems
likely to require apportionment of costs based on time spent by
employees working on development of systems and other
- The term is used as a synonym for depreciation. Depreciation is
the reduction in value of an asset through wear and tear. An
allowance for the depreciation on a company's assets is always made
before the calculation of profit on the grounds that the
consumption of capital assets is one of those costs of earning the
revenues of the business and is allowed as such, according to
special rules, by the taxation authorities. Bannock, Baxter &
Davis, The Penguin Dictionary of Economics, Fourth
Edition, Penguin Books, p.109.
- There are two methods of calculating depreciation: the
diminishing value (or reducing balance) method and the prime cost
(or straight line) method. Under the prime cost method, a deduction
equal to a percentage of the original cost of the plant is
allowable in each income year over its effective life. This method
assumes that plant depreciates uniformly throughout its effective
life. Australian Master Tax Guide, CCH Australia Limited,
- 'Trading stock' includes anything produced, manufactured or
acquired that is held for purposes of manufacture, sale or exchange
in the ordinary course of business (Income Tax Assessment Act
1997 section 70-10; corresponding to Income Tax Assessment
Act 1936 section 6(1)). The definition is not exhaustive.
Anything that is trading stock in the ordinary meaning of that
phrase is also included.
Computer software produced or developed for sale by a software
manufacturer or developer, or acquired for sale by a distributor,
in the course of business is trading stock. Software produced or
developed for licence rather than for sale is trading stock where
the developer or supplier carries on business of trading in
software licences. (Taxation Ruling TR 93/12).
- TR 98/13, states that:
' 4. Apart from the 1998 Budget announcement concerning Y2K
expenditure, the deductibility or otherwise of expenditure incurred
in making computer software Y2K compliant is governed by section
8-1 (the general deduction provision) and not by section 25-10 (the
specific deduction provision relating to repairs). The extent to
which the expenditure is capital or of a capital nature, and
specifically excluded from deductibility under section 8-1, depends
on the type of work undertaken ...
7. Subject to paragraph 8 below, expenditure incurred in respect to
what is, in essence, the complete replacement of computer software
(eg substantially rebuilding software or acquiring new software) to
achieve Y2K compliance, and testing the replacement, is of a
capital nature and is treated as an acquisition of new software.
The written down value of the replaced software can be written off
in the year it is replaced. Rewriting of source or assembler codes
does not, by itself, constitute a replacement of computer
8. However, under the Government's 1998 Federal Budget proposal,
expenditure incurred in respect to complete replacement of computer
software, and testing replacement, is immediately deductible if it
has the predominant nature of ensuring Y2K compliance. The proposal
only applies to such expenditure incurred after 10.00am (Eastern
Standard Time) on 11 May 1998 and up to and including 31 December
- Explanatory Memorandum, p.4.
- David Hastings, Deloitte Touche Tohmatsu, reported in the
Australian Financial Review, Budget 98 A5, 13 May 1998.
- CCH Tax Week, Issue 19 - Special Budget Issue,
- International Rules:
United States: Fixing developed or leased software is deductible
but the cost of new software is not claimable and must be
capitalised and depreciated.
Britain: In-house or external projects to rectify software are
deductible unless part of a major new project instituting other
changes of a capital or strategic nature. Replacing old hardware
with Y2K compliant systems must be capitalised and
New Zealand: Diagnosing, correcting or testing existing software is
a capital improvement that extends software life and must be
capitalised and depreciated.
Singapore: Y2K costs are expected to be capital but eligible for
100 per cent write-offs.
Buffini F, Tax relief uncertainty for bug-fixing by
business, Australian Financial Review, 20 April 1998.
- The Australian Society of Certified Practicing Accountants
Small Business Health Index in April 1998 indicated that 78 per
cent of small business had not spent any money addressing the Year
- Crowe D, Higher costs for software projects, The
Australian Financial Review, 14 May 1998.
'Whatever they've given us on the Y2K front they've more than taken
away with this amortisation ruling', Duncan Baxter, partner for tax
services at Deloitte Touche Tohmatsu.
'This is a change which will affect business in all future years
while the tax deductions now available for Year 2000 costs will
only apply up to the year 2000', Roger Penman, spokesman for the
Institute of Chartered Accountants.
- Price Waterhouse, 1998 Federal Budget Analysis,
- The Explanatory Memorandum (at paragraph 20, page 10) suggests
that where a project is undertaken in the same place as
business-as-usual activities it may be extremely difficult to
accurately apportion costs such as utilities or salaries of support
staff not directly involved in the development process and
therefore it will not be necessary to treat such costs 'as
expenditure on software' for new Division 46
However, Taxation Ruling TR 98/13 refers to the obligation to
'apportion the expenditure on a reasonable basis'.
22 February 1999
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